by Dan Burrows | January 21, 2014 1:45 pm
The U.S. dollar has been trending down since mid-summer, but now that the Federal Reserve is tapering its bond-buying program and the economy is accelerating, the mighty greenback might be ready for some sustained upside in 2014.
And that could be a problem for investors.
As good as it might be for national pride, a stronger U.S. dollar causes plenty of problems for American companies. The biggest headache is that U.S. products become more expensive in international markets. Not only does that hurt exports — and top-line growth at U.S. multinationals — but unfavorable foreign exchange reduces revenue too.
A stronger U.S. dollar will pressure sales at companies ranging from Caterpillar (CAT) to Procter & Gamble (PG) to Oracle (ORCL), and that will take a toll on the broader market. Indeed, 45% of S&P 500 revenues are generated overseas. That means a stronger U.S. dollar threatens sales — and ultimately profits — at nearly half the companies in the broader market index.
But that doesn’t mean all investments and trades are doomed by a stronger U.S. dollar. There are plenty of plays that will benefit from the trend, and some that could even breakout. Here are three of the better strong-dollar trades:
The most obvious and direct way to play a rising U.S. dollar is to bet on the greenback. That’s most easily done through the PowerShares DB U.S. Dollar Index Bullish ETF (UUP).
This exchange-traded fund tracks an index comprised of six major world currencies: euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. So when we talk about the U.S. dollar being weak or strong, we’re talking about the level and direction of the UUP.
UUP topped out at around $27 during the financial crisis, but years of Fed easing brought it down to $21.50 at the end of 2013. Since then however, UUP is up nearly 2% and looks poised for more gains.
The Fed is easing up on its bond-buying program at the same time as Japan is working to weaken the yen. The Bank of Japan is desperately trying to break a decades-long pattern of deflation, as well as boost exports.
So far it’s working. The yen fell about 14% against the U.S. dollar during the past year — great news for Japanese car manufacturers like Honda (HMC) and Toyota (TM). Honda saw profits jump 46% in the most recent quarter, thanks to surging sales in the U.S. Meanwhile, Toyota said its most recent quarterly profits surged 70%, driven by U.S sales.
Toyota and Honda stock are the best plays in the industry for U.S. investors because they’re the only Japanese automakers that trade on a major exchange here (NYSE).
Just as U.S multinationals take a hit on a stronger U.S. dollar, foreign multinationals with lots of U.S. sales get a boost.
There’s a long list of overseas companies with significant U.S. revenue, but one of the best is Diageo (DEO). This U.K.-based alcohol company’s portfolio of brands is enormous, including Johnnie Walker, Ketel One, Tanqueray, Guinness and Dom Perignon.
That stable of premium brands allows Diageo to have pricing power. Throw in a weaker U.S. dollar, and you get nice organic sales growth (that is, revenue excluding the effects of acquisitions). In the most recent quarter, DEO said North American organic sales rose more than 5%, helped by price hikes and a weaker dollar.
The 3% dividend yield on DEO stock looks good too.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
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